Full interview at inpractise.com

We recently interviewed the former CEOs of Aldi UK and Lidl UK on the pillars of hard discounter business models.

With the former CEO of Aldi UK, we explored how Aldi looks at entering new markets and the story of how they built their UK presence. Aldi was willing to sink GBP 500 million into operations in the UK market and wait over a decade before reaching profitability.

We also looked at how the (short-term) management incentive structures of publicly listed incumbent retailers can play to Aldi's advantage when entering new markets.

We covered:

  • The Pillars of the hard discounter business model (approach to product assortment, customer value proposition, low cost operating model)
  • Discounter pricing strategy and price positioning vs mainstream retailers
  • Aldi's approach to market entry: key criteria Aldi looks for when evaluating the attractiveness of a market to enter
  • Aldi Market entry economics: typical capital investment Aldi has to make when entering a new market to reach break-even
  • How Aldi and Lidl have adapt their offering to the local market over time
  • Aldi's approach to managing costs: how Aldi has put cost control at the heart of corporate culture
  • Aldi’s cost structure of operations vs a mainstream retailer

It’s an incredible case of market disruption: Lidl and Aldi have grown from ~2% of the UK market in 2000 to a combined 14% today. The UK grocery industry's profit pool is down approximately 50% in that period. Food retail industry EBITDA margins are down from ~9-10% in 2000 to ~3% today. The net effect of Aldi and Lidl’s slow but steady entry into the UK market has been a massive rebasing of pricing in the whole industry.

The entire management teams of the big 4 UK grocery incumbents have been fired in the last 5 years.

The story is far from over, as it looks like incumbents in the UK and the US are still struggling to grasp the impact of the hard discounters on the market and the almost certain need for more price investment to stem further market share losses to the discounters.

If we can go back in history to your words: Aldi’s assault on the UK, where you got involved at a very early stage. The earliest stage of Aldi’s presence in the UK. Can you take us through what the logic was for market entry and what makes a market particularly attractive to a hard discounter like Aldi?

I’m happy to do that. Some of the points might be a bit surprising, to be honest. When a discounter like Aldi, I have to say my knowledge is that Lidl is similar in its approach is looking for new markets. It has a number of criteria which are important for it to feel comfortable and to feel confident about that market. The first is probably obvious. They’re looking at the discount penetration. If there is none and when Aldi was looking at the UK, there was just a firm called: Quick Save that seemed to be struggling a little bit in its positioning and its success. That was it. There was no other player on the market, and they had around two and a half percent of the market. Discount penetration is a critical first factor. To give you an example. If you were a new discounter, you wouldn’t be choosing Germany as your next market to try and penetrate because there’s already 45 percent of the entire market controlled by discounters there. That’s number one.

Number two is that you’re actually looking at how rich and successful the industry is. To give you some benchmarks and examples. Across the world, on average, a good food retailer can earn five percent EBITDA and three percent net profit. If you’re anywhere above that, the industry would be considered rich. When Aldi entered the UK and was doing its market entry study, most of the good players who were dominant on the market had actually double-digit EBITDA figures, more than ten percent. Double what the global average was. What that actually means is that they had relatively high prices. They could get away with that, the customer was quite happy to pay those prices because they were good operators and because there wasn’t any alternative. The customer could afford it, too.

What that means for a discounter is it will not have to invest so much money to be significantly cheaper than the incumbent on the market. The third element is that you need a consumer who’s been by global standards, let’s talk GDP per capita, rich for a generation. What happens when you have that kind of situation is people have expectations of what they consume. They are not willing to eat things that they don’t like just to get enough calories inside them. They have enough money to be able to consume exactly the quality level and the taste profile that they’re either used to or want. Furthermore, the postman and the hedge fund manager, at the core of the diet basically eat the same things. Same cornflakes, same jam. Same milk, same beer. Same cheese. Same bread. All the core of the diet is pretty consistent irrespective of what you’re earning. It only diverges when you talk about niche products. The postman is not buying champagne every week, but that’s not the core of the diet either to be honest.

This is very important to a discounter and why? Because a discounter wants to come with one product in every particular category. Not a wide choice of product, but one product and it’s got to appeal to the majority of people in order for it to be successful. Finally, as a hope, I would say, a discounter like Aldi when entering a market would prefer that its competition is stock market listed. Stock market listed companies have programs, management incentive schemes, which means that the management is not likely to react to a new threat until the last minute. They’re whole compensation package, what is expected of them as a management team, their contracts, their job descriptions are all based on maximizing shareholder value, maximizing profits.

Taking some threat 15 years into the future and trying to cancel it out now by reducing your prices and reducing your profit, that’s just not on the agenda of a publicly run company before it has to. It buys the discounter a period of time of going under the radar. Nobody takes any notice of it until hopefully from the discounter’s perspective, it’s too late. These are the criteria that somebody like Aldi is looking for.